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New York State's first deputy superintendent of insurance, Kermitt J. Brooks, thinks it's a good idea for the federal government to have a bigger role in regulating insurance -- as long as it's done in partnership with state regulators.

Speaking at a meeting sponsored by E.G. Bowman Company, a top commercial insurance brokerage based in Manhattan, Brooks pointed out that state insurance departments nationally have 8,000 employees expert in insurance regulation, while there are only a handful of people with such expertise in Washington, D.C.

“AIG is cited as the poster child,” for what’s wrong with insurance regulation, “but AIG is not a good example of state regulatory problems.” Just the opposite: AIG was brought down by the parent company’s investments in collateralized debt securities, which are regulated by a federal agency. The insurance giant’s state-regulated operating companies, in contrast, were sound and well capitalized.

It was a failure of bank regulation, not insurance regulation, that was at the core of the financial meltdown, Brooks said.

State versus federal regulation is a “false dichotomy;” instead, insurance regulation should be a partnership, he said.

The financial crisis provided state regulators with several lessons.

First, it showed the importance of “group supervision,” Brooks said. State insurance regulators can’t just look at the operating companies; they also have to know what’s going on with the parent company. When the AIG holding company got in trouble, the operating companies were downgraded too.

It also showed the need to regulate system financial risk, as exemplified by CDSs, and get better management of ancillary funding programs—an issue in the life insurance industry. Also crucial is strengthening the “firewall” between the holding company and its operating companies.

Brooks also said experience showed that the rating agencies’ purview of complex financial products showed “lack of due diligence, flawed models” and even fraud. And there’s lack of transparency how the agencies make their ratings.

Brooks discussed bills in Congress that would revamp financial regulation. The proposed financial supervisory council, which would include the FDIC, SEC and other federal agencies is a “good idea,” but state insurance regulators “should have a seat at the table,” he said.

Brooks was supportive of the proposed Office of National Insurance (ONI) but doesn’t like the feature that could preempt state solvency laws when they conflict with federal law. He is also “concerned” that the ONI could eventually preempt 150 years of state experience protecting insurance consumers.

On plus side, a federal insurance office could sign treaties with other countries, potentially opening foreign markets to US insurers. States can’t do this.

An optional federal charter, where insurers could choose to be regulated by the federal government or the states, would be a “serious mistake,” Brooks said. It could cause a “race to the bottom,” as insurers would seek the softest regulatory touch.

Another federal bill would establish the National Registry of Agents and Brokers, or NARAB, which would give agents and brokers licensed in one state a “passport” to do business in any state. The current bill has “technical problems,” but the concept is a sound one that both Brooks and the National Association of Insurance Commissioners support.

Reviving NY Insurance Exchange

New York officials hope to revive the New York Insurance Exchange in 2010, Brooks said. The original NYIE operated in the 1980s but wasn’t successful.

Getting state and federal tax relief is the “key to success,” he said. An advisory committee is working on it, and New York Gov. David Paterson fully supports reviving the exchange.

A revived NYIE would bring jobs and insurance capacity to New York, but it’s far too early to say just how it would work, Brooks said.